This guide is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. FX hedging products carry risk, including the risk that rates move against you and that you may be asked to provide collateral at short notice, which could affect your cash flow. Comments from Toby Osborne, CFO at Alt21 are contained within the article. As an Alt21 employee, his comments reflect his own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary. Please read the full disclaimer at the bottom of the page.
Exchange rate management can easily become something your finance team thinks about after a commercial decision has already been made.
You agree to the price. Commit to the supplier. Build the forecast. Then, somewhere between that decision and the money changing hands, the exchange rate moves.
Managing that rate earlier may give you more information to work with. If you know the exchange rate you’ll use for a future transaction, you can understand its cost in your home currency before settlement. That figure can feed into the price you quote, the margin you plan and the forecast you take to the board.
This guide looks at exchange rate management through that lens. We’ll explore how businesses identify and manage exchange rate exposure, the techniques available and what changes when the rate becomes part of the planning process rather than something you discover on payment day.
Quick summary
Exchange rate management is the process of understanding how changing currency rates affect your business and help you decide how you’ll manage that exposure.
For a finance team, that can include:
- Identifying future foreign-currency payments and receipts
- Understanding how rate movements could affect their value
- Deciding how much exposure you’re prepared to leave open
- Using tools such as Forward Contracts or FX Options where appropriate*
- Building agreed rates into budgets, forecasts and commercial decisions
- Monitoring exposure as your underlying cash flows change
A known future exchange rate can give you a figure to use in your planning before the currency transaction takes place.
That can change the role FX plays in your business. Instead of discovering the sterling cost of a €500,000 supplier payment when you exchange the money, for example, you may be able to work with an agreed rate months earlier.
What is exchange rate management?
For businesses, exchange rate management is the process of understanding your currency exposure and deciding how you’ll deal with the effect of changing exchange rates on future payments, receipts and balances.
Say you agree to pay a supplier €500,000 in six months.
You know the invoice amount today. If your business holds sterling, however, the final sterling cost will depend on the GBP/EUR exchange rate when you buy those euros.
- At GBP/EUR 1.20, €500,000 would cost approximately £416,667.
- At GBP/EUR 1.15, the same €500,000 would cost approximately £434,783.
The supplier hasn’t changed the price, and your order hasn’t changed. The difference comes from the exchange rate used to fund the payment.
Exchange rate management gives your business a framework for dealing with that moving part.
You may choose to leave the exposure open until the payment date, or you might use a Forward Contract to agree a rate for some or all of the future transaction – though this creates a binding obligation to transact at that rate, even if the market later moves in your favour. Depending on your circumstances, other FX hedging products or techniques may form part of your approach.
The management of exchange rate risk also extends beyond individual trades. Finance teams need to know which exposures exist, when they’ll happen, how reliable their forecasts are and how hedging decisions fit into wider budgets and commercial plans.
The rate isn’t just a treasury number
Exchange rates are often discussed as though they sit neatly inside the finance function.
The consequences rarely stay there.
Consider what happens when your sales team quotes a customer for a twelve-month contract that includes costs denominated in another currency.
The quote contains assumptions about those future costs. Those assumptions feed into the price offered to the customer and the FX margin expected by the business.
If the exchange rate changes before those costs are paid, the contract’s economics can change with it.
The same principle can apply when you’re negotiating supplier contracts, planning overseas payroll, approving budgets or deciding whether a new commercial opportunity works financially.
Your exchange rate assumptions are already part of those decisions, whether they’re explicitly written into them or not.
Toby Osborne, CFO at Alt21, has seen what can happen when FX is separated from the commercial planning process. He once reviewed a sales plan that hadn’t factored in the foreign exchange costs associated with the proposed activity. Once the currency exposure and associated costs were included, the economics of the plan changed significantly.
As Toby remembers it:
“I can always remember him walking out of my office going, ‘It was a fantastic idea if it wasn’t for the foreign exchange.’”
The lesson wasn’t that FX should determine whether a commercial idea goes ahead. It was that the currency exposure needed to be part of the numbers used to assess the idea in the first place.
What knowing your future FX rate lets you do
When you know the exchange rate you’ll use for a future transaction, you can bring that information into today’s decisions.
It can then become an input into your pricing, commercial commitments and financial forecasts.
Price with a clearer view of your costs
Imagine you’re preparing a quote for work that will generate £1 million in revenue.
Delivering that work will require €400,000 of supplier costs over the next nine months.
You can convert those expected costs using today’s exchange rate when you calculate the price. But today’s rate isn’t necessarily the rate you’ll receive when those payments are eventually made.
If your circumstances and objectives make hedging appropriate, agreeing a future rate can give you a known exchange rate for those planned transactions.
Your pricing team can then work with a defined currency assumption when calculating the contract’s economics.
This becomes particularly relevant when margins are tight, or customers expect you to hold a quoted price for an extended period. Additionally, when you’re competing aggressively on price, a smaller margin can leave less room for the home-currency value of your foreign-currency costs to change before the economics of the contract start to look different.
Toby puts it this way:
“If sales are wanting to quote aggressively, if anything, the more aggressive they want to be, that implies the more certain you have to be of achieving it.”
That doesn’t mean finance needs to dictate the price. It means sales and finance need to understand the exchange-rate assumption behind it.
Commit with more information
Commercial decisions are often made months before the related payments take place.
You may sign a supplier agreement today with payments spread throughout the year, approve a project with costs arriving several months later or agree customer pricing before you’ve paid the suppliers involved in delivering it.
Exchange rate management lets you bring information about those future currency costs into the decision earlier. Where you have an agreed exchange rate for a future transaction, finance can use that rate when modelling the commitment and assessing how it fits within your forecasts and commercial plans.
Toby sees the commercial decision and its currency exposure as part of the same planning process:
“People think, ‘I’ll get a contract, and then I’ll manage the FX risk later.’ No, the two should be together.”
That can mean considering the currency exposure while you’re negotiating supplier terms, pricing a customer contract or assessing a capital investment, rather than waiting until the resulting payment becomes due.
You’re deciding with more of its financial inputs already established.
Forecast with rates you can explain
A forecast is built from assumptions.
If your business has material foreign-currency cash flows, exchange rates may be among them.
You might build next year’s budget using GBP/EUR 1.18. Three months later, the market is at 1.14. The commercial activity could be tracking exactly as expected while the home-currency value of your costs or revenue begins to look different.
Hedging some future exposure can replace an assumed exchange rate with an agreed rate for the amount you’ve hedged.
That gives finance teams a clearer basis for forecasting those transactions and explaining variances later.
Your forecast will continue to evolve as sales expectations, costs and payment timings change. Where you’ve agreed an exchange rate for a future transaction, finance can build that rate into the forecast and update the remaining currency exposure as the underlying cash flows develop.
When should exchange rate management enter the process?
Ideally, while the commercial numbers can still change.
If you’re preparing a customer quote with foreign-currency costs behind it, the exchange rate can form part of the assumptions used to build that price. If you’re negotiating a supplier agreement, it can feed into the home-currency cost you’re modelling. If you’re preparing a budget, it can sit alongside the other assumptions supporting your forecast.
Timing becomes particularly important when a commercial process takes weeks or months.
Toby points to customer quotations as a simple example. A price calculated using one exchange-rate assumption can become outdated if the customer accepts several weeks later and the currency has moved materially in the meantime.
The same principle applies as a deal progresses from quote to signed contract. Once the commercial commitment becomes firmer, finance has more information about the underlying exposure and can reassess how it fits within the business’s exchange rate management approach.
By the time an invoice reaches payment day, many of those decisions have already been made. Bringing FX into the process earlier means its potential impact can be considered while pricing, costs and commitments are still being established.
Exchange rate management starts before you hedge
Using an FX product is one possible part of exchange rate risk management.
Before you reach that stage, you need to understand the currency moving through your business.
Suppose you expect €1 million of customer receipts over the next six months and €600,000 of euro-denominated supplier payments over the same period.
Looking only at the €1 million of incoming revenue could lead you to overstate your exposure. Some of those euros may be available to meet your euro costs, leaving a smaller net position to consider.
Timing matters too. Revenue expected in June can’t necessarily fund a supplier payment due in April.
Your forecast also needs context. A signed €250,000 customer contract gives you different information from €250,000 of potential sales sitting in your pipeline.
Good exchange rate management therefore depends on visibility across the underlying cash flows.
Once you understand those cash flows, you can decide what role hedging might play within your wider approach.
Exchange rate risk management techniques
Businesses have several ways to manage exchange rate exposure. The techniques you use will depend on your cash flows, objectives, forecast reliability, financial position and the products available to you.
Natural hedging
If you receive and spend the same currency, you may be able to use those cash flows against each other.
A business receiving €500,000 from customers and paying €350,000 to suppliers in euros may be able to use part of that revenue to meet its euro costs.
That leaves €150,000 of net exposure to consider, assuming the timing of the cash flows allows them to be matched.
Forward Contracts
A Forward Contract allows you to agree an exchange rate today for a currency transaction that will take place at an agreed future date.
Businesses often use forwards when they have a future currency payment or receipt and want an agreed rate they can incorporate into their planning.
The forward rate isn’t simply today’s spot rate held for later. It reflects factors including the interest-rate differential between the two currencies.
You’re also committed to transacting at the agreed forward rate, and the contract carries counterparty risk. If the market later moves in your favour, you won’t receive the more favourable spot rate on the amount covered by the contract.*
FX Options
FX Options can provide rights around exchanging currency at an agreed rate or within defined parameters, depending on the structure.
They can offer a different balance between exchange-rate planning and flexibility from a Forward Contract.
Options can involve an upfront premium, while other structures may have different costs, conditions and obligations. Understanding how the specific product behaves across different market outcomes is an important part of assessing whether it fits your objectives.
FX Options involve an upfront, non-refundable premium. They are more complex than Forwards or Spot FX and are not suitable for every business.
Learn more about Forward Contracts vs FX Options.
Layered hedging
If you decided to hedge, you don’t have to establish your entire hedge at the same time.
Some businesses divide an expected exposure into portions and hedge them at different points.
For example, you might initially hedge part of an expected six-month currency requirement and increase the amount covered as invoices are confirmed or the payment date approaches.
This can also allow hedge ratios to reflect forecast confidence at different time horizons.
An exchange rate management policy
The techniques above become easier to apply consistently when your team has agreed parameters.
An exchange rate or FX hedging policy can document which exposures you consider, how they’re measured, permitted hedge ratios, products your business can use, decision-making authority and review periods.
Your team then has a hedging framework for handling new exposure as it enters the business.
*Forward Contracts create a binding obligation to transact at the agreed rate, even if exchange rates later move in your favour. They may also involve margin requirements. Forward Contracts are not suitable for every business.
What makes exchange rate risk difficult to manage?
Exchange rates can change throughout the period between making a commercial decision and the related money changing hands. Interest rates, economic expectations, market sentiment and supply and demand for a currency can all influence its value.
Meanwhile, your business is working to its own timetable. You’re signing contracts, issuing forecasts, agreeing supplier payments and planning customer revenue that may materialise weeks or months from now.
That timing shapes the translation exposure you need to manage.
Suppose you expect the equivalent of €1 million in foreign-currency payments over the next year. €250,000 may relate to confirmed invoices due next month, another €250,000 could be expected three months later, and the remainder may depend on orders or projects that are still developing.
Looking at the €1 million as a single figure misses useful information about when those FX payments are expected and how confident you are that they’ll happen.
Your exchange rate risk management strategy can reflect that information. You might apply different hedge ratios to confirmed and forecast exposures, increase the proportion hedged as cash flows become clearer or use a layered or dynamic approach to manage exposure over time.
This also gives your finance team a process for making decisions as payment dates approach.
Without agreed parameters, FX management can become tied to what the market is doing on a particular day. A payment is approaching, someone checks the exchange rate, and the team has to decide whether to transact, hedge or wait. If the rate has moved since the last time they looked, the conversation starts again with new market information.
An exchange rate management process can establish how your team will approach those decisions in advance. You can define which exposures you monitor, how they’re measured, the hedge ratios you may use, who has authority to act and when positions should be reviewed.
That framework can also change how you think about getting a ‘good’ exchange rate.
Imagine you exchange at 1.17 and the market reaches 1.19 the following week. Waiting would have produced a more favourable rate. But you could just as easily wait at 1.17 hoping for 1.19 and eventually need to transact at 1.14.
Neither future market move was available to your finance team when it made the original decision.
Your budget rate, planned margin, payment date, hedge ratio and FX policy give you criteria you can use at the point the decision is made. You can then assess whether the decision followed your agreed approach and supported what the business needed from the transaction.
Over time, foreign exchange rate management becomes a repeatable finance process built around your exposures, cash flows and commercial plans.
That process also needs a feedback loop. Sales expectations change. Production plans move. Supplier requirements develop. An exposure that looked highly likely several months ago may become less certain, while another may move from forecast to committed.
Exchange rate management therefore depends on finance continuing to receive reliable information from the teams creating those exposures. Your hedging activity can then be reviewed against what the business is actually expecting to receive or pay, rather than the forecast that existed when the original decision was made.
Manage today’s money and plan for what’s next with Alt21
FX often enters the process when a payment is due. The invoice has been approved, the commercial terms have been agreed, and your forecast may already include assumptions about what that transaction will cost in your home currency.
Bringing exchange rate management into your planning earlier gives your finance team more information while those decisions are still being made. You can understand the currency exposure attached to a contract, model future payments using an agreed rate where appropriate and see which exchange-rate assumptions in your forecast remain open.
Alt21 brings international payments and FX hedging capabilities together in one multi-currency management platform, so you can manage the money moving today alongside the exposure you’re planning for tomorrow.
You can move money across currencies, see pricing information before you transact and access FX tools including Forward Contracts and FX Options. You remain in control of your decisions, with specialist FX expertise available when you need additional information.
Open an Alt21 account and bring your FX payments and future currency planning into one place.
FX derivatives involve risk and may not be suitable for every business. Product availability and suitability depend on your circumstances, objectives and relevant terms.
ALT21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT21 Limited. Not all applications will be accepted.
